good afternoon welcome to capital account i'm lauren lyster here in washington d.c. these are your headlines for thursday december thirteenth two thousand and twelve municipal bonds traditionally seen as a safe investment were the basis of marin's whitney's crisis warnings in two thousand and ten now she predicted hundreds of billions of dollars in default over the next twelve months which never really came to be but since then we have seen some high profile city bankruptcies particularly in my home state of california so is there a dark underbelly lurking in muni land and how might the fiscal cliff impact this three point seven trillion dollar market we'll ask the author of the warders dot com muni land column long and you may wonder how the fiscal cliff impacts news well it's a potential change to the tax exempt status of municipal bond interest yeah they're

federal tax exempt more you may not know about you know simple bonds and our word of the day plus apple concedes defeat one of the world's coming due after what wired dubbed map map the hawk the libs or its disaster of a map app on the i phone five google mountain is back we'll discuss in loose change let's get to today's capital account. all right let's back up a little bit in late two thousand and ten it was prominent banking analyst meredith whitney is a big call. there's not a doubt in my mind that you will see a spate of municipal bond evolves how many is a spate you could see fifty sizeable defaults fifty to one hundred sizeable default

more this woman out to hundreds of billions of dollars worth of defaults it will be something to worry about within the next twelve months. ok now it failed to play out as she seemed to indicate it would over the following year in turn pretty much ever since we have seen a spate of headlines similar to this murder of whitney unocal was one hundred percent wrong according to a bond pro there however between two thousand and ten and now we have seen cities and counties run into trouble and in some cases file for bankruptcy they reportedly have included san bernardino mammoth lakes both in california central falls rhode island jefferson county alabama a few others are for bankruptcy but have their claims rejected and over the summer stockton california was poised to win then subsequently did file for bankruptcy in line to be the largest u.s. city to fail with the city council halting bond payments so hurriedly talk about what is going on in muni land the risks the rewards the reality is kate long she's

a guest contributor to reuters dot com where she writes the muni land column and i'm so excited to talk about this because i have to say kate we don't cover this ever so i'm so excited to have you here today. yeah so let's just start with a very big picture and tell us where you are in terms of are you more with team whitney who saying they're still going to be more pain in union land they're going to be more defaults more disasters this is not going to end well or are you more in the camp of those say i'll say the david kotok camp who is someone that's been on our show who says whitney was dead wrong ok the key is to do your homework and just avoid the trouble spots that i mean it's a lot of municipal bond in a list that analyzes many many credits at the individual level in the name of the rating agencies and all these folks you know generally feel the land is pretty strong we have weak spots california as you said they've had some structural revenue problems there and there's harrisburg pennsylvania that will probably file

in the next month or so detroit is the very big one but for the most part u.s. credits are strong and the yields in the municipal market are at historic lows we have massive debt. and so generally it's a strong bright picture but there are these kind of dark spots that are isolated but it doesn't equal what meredith whitney believes was a massive wave of defaults for for the mare for the country ok so then let's parse this out a little bit so in terms of the trouble that faces cities and also states to where are the signs of weakness the factors that are the the headwinds and what are the tailwinds for one for example we keep hearing how housing is improving i know property taxes are a huge source of revenue for cities are these improving are these not up to where they need to be or used to be i mean clearly not where they used to be but are they better. they're slowly improving but the thing you have to realize with property taxes is that valuations are done on and generally a rolling three year cycle some places do it on a one year cycle so you still have

a lot of leg and property valuations that are affected how much tax can be collected some cities bumped up the rates they use the mills they use and did collect more but that has been a very big weak spot that's about fifty percent of local governments revenue sources property taxes generally where you see the problems are places that already have a lot of debt and generally of as bad management. in some cases states and cities issue pension bonds instead of contributing to their pension plan so they have these big lumps of pension bonds outstanding but often it's two things it's either too much debt or just very poor management. ok too much debt a story we hear all the time poor management where are these where are the real trouble spots that you're saying ok avoid these these are disasters you named a couple but one i know that's on your radar is detroit which is a very large city i know their finances are a disaster from reading your blog so what's what's the status there. so

detroit at one time had a million three people in it now has about seven hundred thousand people in it they've walked down the infrastructure size the municipal infrastructure size over the years but really hasn't been reduced enough to be able for the tax base to support it they're running the city budgets about a billion three and they're running about one hundred million dollars deficit this year they've been in a ballet with the state to get some proceeds of a bond offering that the state doesn't state did on their behalf but the city council is just been sort of playing games and i think the governor there is fed up with the situation snyder and they just passed in legislature a law that would. allow a municipality that's in distress like detroit to either choose an emergency manager go directly into chapter nine bankruptcy or do a couple of steps that would allow them to manage through the you know their fiscal stress so what do you think it's going to be do you think that they're more on the

path towards bankruptcy or you think they can pull it together. it's really dire there and sort of the hidden question always for detroit is there's a lot of derivatives interest rate swaps and we've had two instances where the banks have pushed them back on detroit using terminations triggers and it's in both cases been hundreds of millions of dollars of cash. she's been a big load that was not planned for and so there's a lot of sort of moving elements parts like that but detroit does not have many many solutions at hand right now other than just really massive layoffs or defaulting on their debt and it sounds like the banks made out pretty well not scenario that they were able to get paid on on those complex derivatives swaps deals and make good on those so generally what happened in both those cases is that the city went on a payout plan with them and paid a couple million dollars a month to pay them off then they didn't give them the banks the cash upfront but

they sort of went on a layaway plan to pay them off although the sewer does system in detroit did issue to pay off a couple hundred million dollars if interest rate swaps to beings ok so let's talk a little bit more about sewage system let's talk a little bit more about the role of derivatives in complex instruments swaps in some of these municipalities because one big that is just laden with scandal is jefferson county and that's a county and the largest municipal bankruptcy we've seen yet this is something that is nearing settlement according to you just to give a little bit of background to our viewers about what happened in jefferson county here's a little ten second backgrounder jefferson counties problems began with a corruption plagued sewer project that when billions over budget who are investments and a loss of millions in tax revenue made things even worse. ok so they ended up filing for bankruptcy they're close to a settlement how was a settlement going to shake out in terms of bondholders taxpayers and the city or

the county excuse me so the bottom totals are have the bondholders will have some recovery and i think a lot of you know could be fifty percent or seventy percent of what their what their principal was but a lot of that depends on the county getting a rate increase for the sewer system through you did and in the case to taxpayers their taxes are going to go up there's no question that are there for the fee on the sewer system and then for the county itself they've cut about a quick twenty five or thirty percent of the employees since they went into bankruptcy so the level of services in jefferson county has been decimated so decimated for taxpayers and for residents there j.p. morgan i know was instrumental in what some would argue setting the stage for their bankruptcy j.p. morgan was involved in a bunch of complex financial products they were peddling to the county swaps derivatives in fact j.p. morgan settled in two thousand and nine with the as you see percent one hundred

million dollars over say secret payments to friends of jefferson jefferson county commissioners i mean it's absurd how did you morgan make out of this deal. they will definitely be have substantial losses through the bankruptcy they've been a primary. party in the bankruptcy proceedings and they they will have losses i'm sure they reserve for it in some way but. they definitely instigated they paid i think almost eight million dollars in bribes to get this business initially and there was just layer after layer after layer of interest rate swaps piled on jefferson county they were all very highly priced so they were way off the market when they were priced it was unnecessary most of it was just blue blue green just it's a real disaster it's a real story agreed years ago. disaster and j.p. morgan you're saying it's going to take some losses but the bigger picture does this hurt a bank like j.p. morgan because i've seen reports that over the last few years j.p.

morgan is anywhere between the top or the number three underwriter of municipal bonds so j.p. morgan shook it off ran the bankers off to did the deals and said that there were not there instances where this happened you know there's been other instances where j.p. haven't is you know illegal things in the municipal market but they are a dominant dominant player in. the rating so they continue to bat be strong in this area just spite the egregious acts one of the things that seems to be recurring theme quickly before we go to break is that a lot of these deals are negotiated privately and do some closure requirements are not great so is this a situation that benefits banks and does or does not benefit taxpayers. negotiated deals you never know whether the issuer is getting the proper pricing when they should get the disclosure side usually you know somewhere within a week or two of when the deals it's really hard you're catching up always you

don't really know and the other thing to bear in mind is a lot of these issuers are just small local communities and you know the guys probably a schoolteacher trace a day in and ninety's of finance you know he's on the board that oversees this stuff and you know so there's a lot of room for you know smaller issues to be taken advantage of right absolutely so we're going to have more about some of these issues where perhaps parties are taking advantage also the impact of the fiscal cliff more ahead with kate long municipal bond writer for reuters also still ahead apple concede defeat part of the world coming to a change the map app back to google maps or at least are allowing that more on that in loose change but first the closing market numbers.

the battle. here is mitt romney trying to figure out the name of that thing that we americans call a dollar. i'm sorry i'm just a guy who cares an awful lot like you sir are a fool you know what that is my self but i want us to defeat terrorism the only ball that chris. can securely but it's.

going to school we're going to distract us from what you and i should care about because there are profit driven industry that sells us sensationalistic garbage he calls it breaking news i'm having martin and we're going to break this that. the books. welcome back let's continue talking about muni land because california has got a few bankrupt cities in my home state it's ok i'm used to california being a mess but one is san bernardino and i know stork fight is actually going on there here's a little of the back story. in me this region have the third highest foreclosure

rate in the country and should be unemployment stood at fifteen point nine percent people are not working they're not paying taxes they're not shopping they're losing their homes forty thousand homes in foreclosure. so negative economic factors needless to say drove that city in part to bankruptcy and now the california public employees retirement system better known as cal pers is engaged in historic fight in san bernardino according to business week it's trying to rewrite the rules for bankruptcy claiming that it should get paid before almost everyone else including bondholders so let's bring back in to ask her what is at stake here so kate long it's been cast as historic what is it stake here in this cal pers fight with san bernardino well basically the it's a question of if the pension rights or benefits of public employees are protected in a bankruptcy setting which means they would get one hundred percent on the dollar

and what bond insurers are arguing is that what is owed to pensioners should be. in the same way that debt is here those are all liabilities of the community and helpers has no reason to ring sense or. protect the pension payments so what do you think would happen depending on how this ruling goes and what way to go go should. it's very it's very odd chapter nine bankruptcy for a minute these is federal law but you also have to account state law because communities are agents of the state so there's a lot of sort of odd twists and turns that are happening in this case but essentially the federal law will prevail the bankruptcy lower prevail and it's likely the bond insurers point will be. will be taken up and the pensions probably most likely somehow will be restructured. it doesn't make sense to me that cowper's

doesn't just go ahead and do that i mean there is no money in san bernadino to give the say force back this hundred forty five million dollars of pension liability simply couldn't have police or anything fire department schools they would have no money so it just doesn't you know it just doesn't really make sense right everyone to get their pound of flesh that they were road prior to the bankruptcy which is one of the tragic things about these bankruptcies is that people lose so then i want to talk about the way that the muni market or the bondholders could lose from the fiscal cliff because wouldn't you know the fiscal cliff touches everything the municipal bonds are no exemption so first before we get to fiscal cliff one of the things about you know simple bonds is that there are tax exempt and the reason i understand that this is the case is because they are tax exempt that makes them appealing to investors so then that helps cities and states borrow for less because their their bonds are attractive which helps them to more easily fun the bridges roads schools that they're building or whatever it is that accurate is that how it

typically does work just add one carrier that is the higher the income bracket you're in the higher tax rate you're in the more evident ages it is to have that tax exemption and show to that income ok which is why perhaps it is one thing that is on the cutting room floor in the fiscal cliff negotiations because evidently according the wall street journal this is one thing that perhaps john boehner and the white house can agree upon that for high income individuals they maybe shouldn't get this tax exemption. anymore how would this impact things oh it's just are very skewed to high income earners now are people in high tax brackets people at the very top get about probably twenty seven percent of the advantage the people in the one percent get about twenty seven percent my own view is that it will really not hurt the bond market the municipal market that much there is massive demand for these bond issuers annual issuances been shrinking year by year so there's less. you know in the end i don't think it's really that big a deal personally the states are going to have to give something up i mean they

they don't want federal funds coming to them cut they don't want to cut you know something has to give in this fiscal cliff play the states have to contribute something to the to the you know to the party so you think that if if this tax exempt status of interest is curbed to an extent it's not going to impact borrowing costs for cities or states dramatically because the demand is so high for newbies it's going to be impacted but you see assessments they range from like ten basis points to you know one hundred basis points and you know it's a function of where interest rates are at the time and stuff the point is there's massive demand in fact many investors are cut out from being in this market just because you know most of the bonds are flowing up to the top income brackets just the way j.p. i'm for example j.p. morgan massive underwriter a lot of those bonds go into their own clients accounts so you know if you're not a client you're less likely to get the bonds. or the others in the end ratings and ok and just quickly before we go why have there been such demand for muni's lately

because people want to shelter their income from dex is. there yamit very avid all right well i appreciate you being on the show thank you so when you're being here and kate long she writes a meal and blog at reuters thanks so much. all right time now for word of the day where we break down a financial term for our smart viewer but just perhaps not the expert and today i bet you could guess it the word is done did it on municipal bonds because we're talking about them and over the past year as state debt mount we have seen a lot of back and forth over the safety of these bonds with headlines including the following could municipal bonds be the next financial titanic or when you've done

still save tax free options just by doomsday talk so it sounds like this is where our guest would fall should we be worried well first how exactly do you mean a simple bonds work i mean a simple bond is this it's a debt security issue by a state municipality or county to finance its capital expenditures ok municipal bonds are exempt from federal taxes and for most state and local taxes the two basic types are general obligation bonds and revenue bonds and just to give you a little bit of context the revenue bond secure principal and interest charges are rent such as toll roads where as the general obligation bonds are supported by the issuers taxing power now for these bonds are often referred to as muni's and they are used to fund state or local expenditures including highways bridges schools that sort of thing these are often bought because of their favorable tax implications as you just heard our guest said people want to shelter their money however this could change as the fiscal cliff looms both republicans and democrats

have agreed to consider taxing a portion of that municipal bond interest but some argue much of the incentive for investors to buy municipal bonds is due to their tax free status and without this municipal borrowing costs are likely to increase potentially leading to increased defaults to a little sense total state debt reportedly exceeds four trillion dollars. the federal government point five percent of me the schools default those or the high yield junk bonds ok so that is how often they actually default yet according to federal reserve bank of new york and a report issued this summer bonded actually occur more then that woman indicated in more than you may think it said although the low default history of miscible bonds has played a key role in luring investors to the market frequently cited default rates published by the ratings agencies do not tell the whole story about municipal bond defaults for example between one nine hundred seventy and two thousand and eleven moody's reported there were only seventy one municipal defaults however the fed

report which looked at a much broader sample including unrated bonds and industrial development bonds counted twenty five hundred and twenty one defaults during the same span so you have a big difference there depending on what you're looking at now we have yet to see the reckoning in the municipal bond market many of called for in the future is up for debate depending on who you listen to but now you know a little more about how municipal bonds work. are let's wrap up with loose change dimitrios xenos so glad you're here because this is kind of a funny story we know you love apple so that's why we chose to have them following on getting off the bat i know it's ok don't tell us about it let's talk about the

story apple's map application has caused some users problems recently we all know about it they've been like this. after several stranded drivers had to be rescued out bullis to fix some serious errors in this new map feature instead of directions to the australian city of milled her driver's down under we're being led to a remote state park with extremely high temperatures and virtually no cell phone reception. is a really a layer is like a really bad practical joke in that example but anyway apple had to apologize or they chose to apologize which was pretty rare for apple and late wednesday night google released their own maps app that apple is now allowing its i phone users to use so google maps is back on on the i phone i think it's pretty crazy i just think do you think it's symbolic because i just feel like you never hear of this without paul not only did they concede defeat but now they really conceded defeat there like we just can't fix a google maps and back that actually there's no question that's actually something

that i was thinking about before which is that. after they got beaten by microsoft and steve jobs came back they built their company around being the best the best software the best integrated hardware the best operating system and now they're just losing because they've reached critical mass and they just cannot possibly grow anymore. i don't know if i would be critical mass in any case but it's funny because long called me before she got here and she was lost because she was looking to google maps which was like are you sure i don't and you can awful i wanted it so badly to be apple so that it would work they really are somebody maybe she just thought it was so she said. you know i double checked it with her because i wanted to know that it worked it did not but maybe that she was here i think in general on a map here is stupid and the thing is like you are kind of authoritarian away but they always got away with it because they were also really great but then they tried to shove this on the consumer's throat and fill because they weren't as good there back it was as good as google's they had they had

a their own client but then they had to go all the way and they just create a really crappy product is it emblematic of where apple. ok their stock price was seven hundred two dollars a share september nineteenth yesterday closed at five hundred thirty nine dollars i'm going to call reggie we got to get him on our let's move on let's talk about the bag really quickly because bill gross of pimco had this to say about their recent decision on bloomberg. if you wrote checks for free and it's costless to finance a fiscal policy that is soon well into deficit figures then yes that's an inflationary moment to the extent that the private sector you know gets a manimal spirits. those animal spirits i don't know i don't know where are they i don't know where they are yesterday they did not arrive at all ok the market didn't really rally bond yields were actually higher and gold was really i mean the market doesn't really seem to care about q.e. anymore if you're one that believes that the market does react to news and it's not a bunch of hooey yeah it's like the bond market has become a little and i used to worry when two thousand and eight came around i used to

worry that with all this q.e. that that was going to put upward pressure on. bond yields but in fact i'm sort of the believe that because the leveraging is so great or the massive debt is so great in the private sector then that in fact of the bond buying that the fed is doing through through the treasury market it's all it's doing is it's lifting asset prices but in fact if they pulled out they wouldn't actually be props there are actually probably the bond market in my opinion the treasury market you think yours are you lower because it was a propping up as it were propping the of the rest of the market would collapse and also remember these banks in the studios where people how's their money are levered so they're going to get worried where are they going to go they're going to go into the bottom or into the treasury market as they know at least they'll get they can figure i was going to try to go with. yeah bar with a blank check as mr gross but i want to leave it there thank you so much for watching be sure to come back tomorrow and you know in the meantime you can follow me on twitter at lauren lyster you can go like our facebook page there it is if you can give us feedback we will read some of it tomorrow at youtube dot com slash

capital account you can watch just in h.d. on hulu there it is and from everyone here have a great night. for you. discipline.